RemovingBarriersto Growthand Employment in France and Germany

1 Ii/! McKinsey Global Institute

with assistance from our Advisory Committee Bob SO1OW, ~airmm” Olivier Blanchard Edmond Malinvaud Hans-Werner Sinn and contributions from Axel Borsch-Supan Hans Gersbach Frankfurf, Paris, Washington March 1997

‘llisreportis copyrightedby McKinsey& Company, Inc; no part of it maybe circulated,quoted, or reproducedfor dktibutionwithout prior written approvalfmm McKimey & Company, Inc.

Preface This report is an endproductof a year-long collaborativepmjectby McKinsey/France, McKinsey/Germany,and the McKinsey GlobalImtitute on the sconomicperfo-ce of France and Germany. McKimey undertcak &is project becauaeof the concern of ourpractices in France and Germany over the impact on society in these countries of high and increasingunexnploymentandslow growth. Wehopedthat McKinaey’sextensive work with companiesand industries in tAese countries and other parts of the global economymight provide additionalinsight into ways to improve economic performance This projectbuilda upm the previous work of the McRinsey Globsl Imstituteinassessing economic performanceamong the leading economiesof the world. C)ureariierreports addressed separately productivity andemployme.nt,lthe fundamentalcomponentsof =onomicperformance. Later, we combinedthese componentsto address overdlperfoxmance at the country level for Swedm and AUSImlia.2This project on France and Germanycontinues OUIefforts to assess economic performance at the country level.

As before, the core of ourworkis conductingindushycase studies to measure differences in productivity, output and employmentperformanceacross counties and to determinethe reasons for the differences. In tbis report theperfonnance of Frsnce and Germany is compared primarily with thel.hdted States, althoughcomparisonwithJapan is made in the automotivetidustry, and with the Netherlandsin housing construction. OLUreport consists of four chapters and an executive sunumq. Cbpter 1 desmibes our objectives and approachfor the project. Chapter2 describesthe analysis and conclusions horn work at the aggregate level for France and Ge-y. Chapter3 includes our six industry case studies automotive, housing construction, telecom, retail banking,retailing, and computer software. Each case gives the results of our productivity,output and employmentperfo-ce calculations and discusses the reasons for the differenceswe found among France, Germany and the other comparison counties. Fmhcase is precededby a summaryof the results of the case. Readers more interested in our generalresults and less interestedin the specifics of the cases may choose to read thes ununaries rather than tie entire cases. Chapter4 presents a synthesis of our findings, including our overall conclusions and the implicationswe draw for policy and corporations. The wOrkingteam members for theprojectoverthe course of the year were: Peter Barth @iiaseldorf); C61ineBachUerie%on (Pti); H61@neBecharat-Reltgen(Paris); Piene-IWce Bernard (Paris); SumnneBoldicb (Diisseldorf);Andreas Bork (Paris);Wolfgang Gnoza (Hamburg);AlyJeddy@kKinsey Global Institute);Michael Klemrn(Fmnkfurt); James Kcmdo (McKinley Global Institute);Cluistianlvfille (Paris);Jikgen Miiller (Trankfurt);andhmmnt Nordin (Paris). Vincent Pdrnade (Paris), together with BernhardBrinker (Mtich), Claus Neuberger (&din), and Stefan %hulze (Hamburg),was responsiblefor the day-to-dayproject managenwnt. 1

Ssmicf SectmProdti”m”ty, McKimeyGlobalInstitute,WAir@on, D.C.,Cktokrl?92; Manu+”ng Produti”uity, McKimeyGlobalInstitute,Washington, D.C.,DctobfrlS93;Emplqnnmt Pqbmzan.z, M*y Globdhtitite, W=ti@on, D.C.,Novem3er1994;~“td Prcd&”ty, MdG.nseyGbbal Imtitute,W.Air@on, D.C.,June1996. 2 SmedcrisEcmomic Pq%rmmce,McKirq-G1obalImtitWs,StmkAolm,S eptemter 1995;AIL5tmIi7’s andMciGnwyGlobalinstitute,Sydney,November1995. Emnmnic PeformanceMcKimey/Awtmha

9703143u3m-26242._OOW21SW

McIGmeysector experb assisted thewoddng team in the conduct of theca~ studies. l’heaector w=JW= K%e -dorf), H=@KerbratF’@), andGkMA Men= (cIevAd) e- automotive; Conor Kehw (Paris/London)and Jiirgen%hrader (Oiisseldorf)- telecom; Heino Fa!3bender@ankhut ), Michael Sa.tter (Frankfurt),and NeilJanin (Raris)-retailban!dng; Fraqois Gl&net @mi.s),Peter Bamenatein(Munich),and Julian Allen (London)- retail; Eric Labaye (I%is), Detlev Hoch (Diiaseldorf),and Michael Nevem (SiliconValley) - software. We were forhznateto have an outsideAdvisory Conunitteefor this project. The Advisory Committee was chaimdbyBob %Iow, MIT, and also included Olivier Blanchard,MIT; Edmond Malinvaud, CREST; and Ham-Werner %m, Universityof Munich. The Advisory Committee had fow alldaymeetingswitb the working team to review progressduring the course of the project. Advisory Committeemembers also providedmany written commentaand participated in several individual discussions. Axel Borach-Supan(Universityof Mannheim) and Hans Gersbach (Universityof Heidelberg)were part-timemembers of the working team and also participated in the Advisory Committeemeetings. McKimeyparIicipanta in the Adviso~ Committeemeetings includedMartin Baily (McKinsey Global Institute), Heino Faflbender(Frankfurt), FrangoiaG16met(his), Ted Hall (San Frarwisco), Herbert Henzler (Munich),Peter Kraljic (Paris), and Bill Lewis (McKinley Global Institute). Hubert Joly (Park) directedthe fimthalf of the project .mdMichael Sautter (Trankfmt) directed the second half. They were assistedby Heino Fat3bender,Fran$oisGl&net, Bill Lewis and Martin Baily. The undertaking of tldaprojectiapart of the hdfilknent of the McKinseyGlobal Inati’mte’smission to help global leaders: (1) understand global economic developments,(2) improve theperformance of theti organizations,and (3)work for better mtional and internationalpolicies.

Bill Lewia Director of the McKinaeyGlobal Institute March 1997

2

970217du3sw_262423-005-F3SW

Contents EXECUTIVE SUMMARY CHAPTER 1 : OBJECTIVESAND APPROACH CHAPTER 2 : AGGREGATESURVEY CHAPTER3 : CASE STUDIES – Automotive – Housing Construction – Telecom – Retail Banking – Retail – Software CHAPTER4 : SYNTHESISAND IMPLICATIONS

970221du3sw-262423_O05-F25W

ExecutiveSurnrnary After decades of steadily increasingprosperity, Germany and even more so France today have sluggish growth and are plagued with rising social costs and high unemployment, especially among the young and low-skilled workers. An increasing number of French and German citizensbelieve they must reform their economic and social systems. The purpose of this study is to provide a fact base for reform. We do this by comparing productivity, employment, and output in France and Germany with global best practice and identifying causes of differences in performance. We then try to determine what governmentsand corporationscan do to close gaps in productivity and job creation. As in other McKinsey Global Institute (MGI) studies, we looked both at the overall performance of the national economy and at the micro performance of key industries: automotive,housing construction, telecom, retail banking, retail, and computer software. Our principal findings are: q Lower economic peformance. Compared to global benchmarks (using purchasing power parities), (West) Germany produces 30 percent fewer goods and services per capita, has 20 percent lower labor productivity, and 15 percent less employment per capita across the industries studied. France lags benchmarksby 40 percent, 20 percent and 25 percent in these three critical measures (Exhibit 1). q World class productivityandstrong employmentpe~ormance cango hand in hand. The productivity leader also has higher employment levels in five out of six cases. For example, in computer software the US has, on a per capita basis, 50 percent more (high-skill)people employed than Germany and France. ~ Secto?spec$cproductmarketregulationsare themainbarriersfogrowthas theyhamperproductivity.They constraincompetition and limit exposure to the world’s best companies. This, together with inefficiencies in governance structures, causes companies to innovate less and rely on less efficient processes, which translatesinto lower productivity and lower overall growth. ‘j Comparatively highminimumwagesandproductmarketregulations,such as restrictive zoning laws have in many cases directly stifled output and employment performance. ~ Bettereconomicandsocialpe$orm.ncecouldbeachievedbydecoupling sociaI and economic policies, for example using income tax policy to alleviate the adverse social impact of deregulation.

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Exhibit1

SUMMARYOF THE ECONOMIC PERFORMANCEANALYSIS AT THE INOUSTRYCASE LEVEL- 1994/95 Indexedto bestpracticebenchmark=100” Output Automotive (vs.Japan)

~,~

70 ; 80:

85

45; 50

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Extibit2

GDP AND LABOR INPUT PER CAPITA IN THE MARKET ECONOMY-la95 Indexedto US= 100

:::”””’s’OO

85 ;

70 : 65 :

. US,$camentioredo merwse

GDP per cepita’

F-

125

:

70’~’ 65”’”

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70 ; 70 : ; :

Wes!GennW

Employment,. 80;

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;

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Tetecom

bborproductivi~ 70 ~ 55 :

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Housing construction

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Labor input per capita..

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...”

970221du3m-262423_O05-F2SW

These findings directionallyhold for both countries, although the situation is more severe in France than in Germany, especially in output and employment terms. The study concentrateson the analysis of economic causality. It does not intend to make recommendationson tradeoffs between economicperformance and other policy objectives and values. Rather our findings illustrate the economic costs of certain policies and provide a fact base for well informed choices. This Executive Summaryprovides only a brief overview of the main findings of this report. More in depth conclusionsand analyses are to be found in chapter 4, “Synthesis and Implications”.

SUBSTANTIAL DIFFERENCES IN ECONOMIC PERFORMANCE The aggregate survey and the cases show that France and (West) Germany trail global benchmarks in both output and employment (Exhibit 2). The differences in output can be traced primarily to the non-manufacturingsectors, which mainly consist of market services. In 1970 the US, France, and Germany all had roughly the same employment in non-manufacturingmarket sectors. Over the last 25 years, however, the amountof work done (labor input) in France and Germany has declined by around 20 percent, while the US has seen this number increase by nearIy40 percent (Exhibit3). The picture is slightly more complicatedin labor productivity. The cases, which cover roughly 20 percent of the market economy, suggest that France and Germany trail the benchmark countriesby 20 percent, yet the aggregate numbers for each country compared to the US suggest that at least Germany actually holds a slight lead in labor productivity. We believe the industry case results give a more accurate picture than the aggregate numbers of the potential for productivity increases in the market sectors in Germany and France. On one hand, distortionsresult from difficulties with output measurement, because the service and conveniencecomponents of services output are often considered inadequately at the aggregate level. In addition, many low value jobs, which decrease aggregate labor productivity in the US and which are particularly important for example in personal services, cannot exist in France and Germany because of significantlyhigher minimum wages. Cutting off these low-valuejobs increasesunemploymentand, at the same time, increases average labor productivity among the remaining employees. While it is always preferable to create high-value,high-payingjobs, low-value jobs allow low-skilled people to work, which may avoid social exclusion and provide at least a chancefor moving up the income ladder. The US has created a huge number of these jobs in industries such as retailing. In total, the US employs 50 percent more people per capita in retailing than France and Germany. The low level of minimumwages has led to a more unequal income distribution in the US as compared to France and Germany. As a matter of social

2

Exhibit3

LABOR INPUT IN NON-MANUFACTURINGMARKET SECTORS -1970-1995 Fulltimeequivalents(adjustedfordifferencesin hour.sworked) per 1,000capita

—us

--we,, C3ermany . . . Fr-

3oo280 260 240 220 -

180 *-. 160 -

\

140 o-~ 1970

1995

- ]ti@iwmarketStis, agri..lure,cunwudkm,ulilill es,ati mining (tkhnerfo.rar.lnclti& lormeSur.ment reamns) Sa.rce: CO.4aim,OEcDNati.d A~.nts.lNsEE mmp!w,statis!tihe$B.ndeSmt,BEASCB. EWO$IMPPP,OECD PPP,[email protected]. JUOOk. 0EC0~D13, MtiiIW3Y

=970129.pA.mmm.FB.xID

Exhibit4

NET JOB CREATIONIN SERVICESIN THE US -1990-1995 Breakdownof job creation in market services -1990-95 = ~

13.5

100%+ Other.’

Net job creation Per 1,000working age population’

22

Occupations Executive,administrative,managerial

14.6-

Sewice occupations Salesoccupations

wor tg age pop ation.

P

14’01

4

. ComputersystemsanalystsJ scientists . Socialworkers . Lawyers

1.1 —

0.5

D

Operators,fabricaters,Iaborars

, Otheroccu: patiOns

. Generalmanagers,top executives .“‘a”a!eme”’ana!ys’s MarkeIng,advemsmg,public relationmanagers

78

-, b ~reatlo” ; mi : per 000 of

Esamplesof specific Occupations with biggestjob growth

I

Professional specialty Setvices..

Jobcategorieswitha kvemedianwagelevel.... Jtim!qorieswi! hklowmtiia.wagelevel....

. Gua[dsandpolice(excluding

0.5

-0.1

--i

I

. ~;::z:::$peso”al setices . Attendants,amusementand recreationalfacilities

- N.m&rofws, adj.s!titorgroWhinwotiingag.pp.lation,b.t~! adj.sltiforp.n-timework .. ~Mrm.rketsewices:8.nspation(+!.2),wkJeSl. atiretailtiade(+22), fin.rrceJns.ranc#eal esl?!e(.1.71 .::: ;:~;:s~wi”esaM,eP.,,, WmnalexePI Pn”.teti”Shold,en!etiinme”t, rsreaUO”al, ati P,ofeS,oti%wWsex,ePthe.ltiandeducalion mcomein 19%intietomlWn.my{or Mleworker,:US$522 SQIJma:BLs:MmwLrRetiw, J"w,B6,us$mtis!8ti*s,r.ct:McKinsey

/

-E9.PA.WO15-XU2.EB.XID

Exhibit5

HISTORIC SHARES OF EMPLOYMENTIN DIFFERENTSECTORS-1900- 1S95

---

Sertim,

—-

Indw.!!y Agtic”ture

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.. L Ii L Italy

80 70 , ,’ # , #

60 50 40 30 .F 20 10 0[ 1901

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1995 1907

. Mmufaclurirg, cnnsbmcti.n, Milks, minicq .- Forl-, Swslndtiep.blic .tilitie. bum%:OECDEn@qmentSNdy

us’

/

970221du3m,-262423_O05-F2SW

choice, however, governmentscan still create appropriate mechanisms to redistribute income. Increased job creation needs not be confined to low-valuejobs. More than 80 percent of the new jobs in services from 1990 to 1995 have been created in categories with better than median wage levels in the US (Exhibit 4). In computer software, where jobs are high value and well above average income, the US employs 50 percent more people per capita than either France or Germany.

BARRIERS TO HIGHER OUTPUT AND EMPLOYMENT Our analysis showed that differences in economic performance were caused by barriers to higher productivity and barriers with a direct negative impact on output and employment. Removing those barriers would improve performance in the sector directly affected and also have positive economy-wide spillover effects. Barriers to higher productivity Removing the barriers to increasedproductivity emerged as the primary means of fostering growth and economicrenewal in France and Germany. This finding may come as a surprise to those who believe that productivity improvements come only from “downsizing”and result only in job destruction and higher um employment. On the contrary, increasing productivity through more valuable products and services (innovation)emerged from our industry case studies as the most important way to increase output and create high-valuejobs at the same time. In all industries studied except automotive, the productivity leader was also the employment leader. Making improvements in process efficiency across the board and relaxing constraints on product and service innovation (includingnew business formation) is the only way to achieve benchmark economicperformance. This is the process of economic evolution in which employment shifts first from agriculture into both industry and services, and then from industry into services (Exhibit 5). And the experience of many countries, includingFrance and Germany, over the past century is that vast improvementsin productivity, and the associatedshifts of employment, can be accomplishedwithout any long-term increase in unemployment. As the evolution of the economy takes place, some current jobs will be lost. There will be many industries and companieswhere more efficient processes free UPresources and reduce employment. However, the composition of output is not fixed either. The development of new products and services can create enough new jobs to reemploy the workers who are released, as well as encourage

3

ES970129PA-~W2502-BB.XID Exhibit6

IMPACT OF HIGHER PRODUCTIVITYIN ONE INDUSTRY ON OUTPUT”

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CAUSALITY FOR LABOR PRODUCTIVITYDIFFERENCES IN WEST GERMANY/FRANCE- SUMMARY

Osecmdary x Utiiffemnti.li* / Wesc%mmymmc=s (ildiffewn!)

Resultofsectorcases

soft(vs.Japan)constr. combankingRetail ware %/0 x/o x x x x —————————————— AutomotiveHousing ‘rele- Retait

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.—————————————. hscalandm acro.econom!c env,rcmmmls . %ductmarket - Competifionlconcentration rules -TradeFD1barders – Prod.ctreg.lations - Otherindustriedup-and downstream . Labor market - Labor mledunionism – Relative laborc os! .raFta-mzkeT ————————— - Corpwate govemancefgovemment ownership – Relatlvecost ofcapitahtemediation . Competition wifhbestpractice . Domestic competitive intensity

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*/o x . Mixofproducts andservice?/marketing —————————————— .—Pr6Tiiih7a~0rF———————— : “: : - Capital intemifyltechndcgy xx C!J* x x x x Xxxo - Scale - Latmrskill andmotivation ——*Q 3——S—3 ——x——x . operations – Organizaticm off.ncdonsand tasks x u% 05 x ● f ./0 n.a. n.a. n.a. x - Oedg.forrnan”fact”ri”g ● 1= -SupplieEmdWpplierrelatihip OX *XX 70 45 85 10D 84 Prod.cfivitypertormanm (G) :0 (133stpratics= 100) 80 5D 180 10D 70 (n 55

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2 EVfat”ing3.10 WrmnmF*”Bof m.wrtilprd@* gffere-. 3 E@&.(”gO-3pr-”tige F.boftioWrtiprtiW ddfererms @p,OdUCI rR.@rC@dfSer@ !awerpmsswefr.m.n m+rsard a HigIW,fiWtiIomSW,.(BUI@ 5 Comp-ansati”g efffctsb3hwee” frad,lmMstwesardlqatifomats 6 Higherrnin!rn.mwag+s o4tkgoHlowval.esericas source: McWnsay

lessrnmpation[in France)

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970221du3sw_262423-005-F2SW

hiring from those who are currently unemployed (Exhibit 6). The new jobs will be predominantly high-valuejobs, mainly in service industries. In our cases, we found evidence for lower productivity in France and Germany resulting from both a lack of innovationand the use of less efficient processes (Exhibit 7). Product market regulations and, to a Iesser extent, inefficiencies in governance structures were identified as the main causes for reduced competitive and shareholderpressures, which would have spurred companies to innovate and improve process efficiency. Labor market regulations as well as differences in fiscal and macroeconomicenvironmentswere rroffound to be differentiating factors with regard to productivityperformance. In the autmrmtive industryexplicit or implicit barriers to trade and foreign direct investment shielded European manufacturers(especiallyin France) from Japanese best practice, contributingto 30 percent and 45 percent productivity gaps in Germany and France respectively. Foreign and specializedplayers in French retailbankinghave been discouraged by product market regulations determiningpricing and distribution of (subsidized)mortgages and deposits. These regulationsprevented product differentiation and created a non-level playing field. Governments did not provide the appropriate incentives for telecmrrs to price local rates according to their true economic costs. The resulting overpricing led to significant underutilizationof the phone networks - people in the US, on average, use the phone more than twice as much as in Germany or France. In the housingcorzstructioir industry,productivity is negatively affected by the fact that local communitiesin Germany, and to a lesser extent in France, do not designate large enough areas of land for large constructionprograms, which would enable developers to reap significantbenefits from economies of scale. This conduct is fostered by the relatively low importance of the property tax as a source of financing. As a result, communitiesare not able to count on future revenues to offset high initial expenses associatedwith rapid urban growth. Barriers with a direct negative impact on output and employment Higher minimum wages and restrictive zoning laws were found to have a direct negative impact on industry output and employment. This is particularly true in retailing. In France, for example, the significantlyhigher minimum wage than in the US has led to 15 percent lower labor input within comparable retail formats. With less staff at their disposal, retail managers are forced to reduce the level of services offered to their customers. Toys ‘R Us, for example, employs in exactly the same stores about 30 percent fewer people in France than in the US. In addition, retail output is directly hurt by stringent zoning laws which lead to higher land costs. Overall, this higher cost structure has effectively prevented

4

-,., ‘—. -ra.awmw...na --. —-----‘-3D Exhibit8

IMPORTANCEOF LOW SKILLED LABOR IN THE US -1995 CCWCEPTUm

NUMBER OF JOBS IN THE US L

.._.~

26%

: WAGE COSTS”

US minimum Frenchminimum wagecosts wage costs (US$5.1) (Us$ 9.3””)

. [email protected] l.krmmwnmti.n:26%.1 USlabrisempl.~atkl.w Fre.ch minim. mwagec.ss(.wrwhinnmrketse.a.rs); inFrame 5Y..lkhr l.estimatti t. beempb~athbwmti..alminim.mmgems~ .. CQ”V,rledat 1S93GDPPPP, inflatedto 1995US$ .So”rca: McKinsey

Exhibit9 EXTERNALSOFfWARE AND SERVICESSPENDING PER CAPITA PER SECTOR-1994 US $, convenedat GDP purchasingpowerparity

us

France

m

Seclorswim !srgesgaps

Germany’

Manufacturingsectors Manufacturing

84

Agricultureiconstructionlmining Market services sectors

64

4

67

4

Transpotiation,communication, utilities

49

RetailAvholasale

19

34

Financialservices BusinessseNices

16 37

29 23

16

18 63

Otherservices

3

23

9

9

2

3

Non-marketsectors Government Heaith

13

Education Total

. TolalGermany SOUrca:IKJQOECD

35

30

20

5

4

9

@

8

A

m

970221du3su,-262423-005-F2SW

the development of many high service, innovativeretail formats in France and Germany. The US minimum wage costs in 1995 were only about55 percent of the French level, and less than 50 percent of the collectively agreed minimum wage costs in the retail industry for low-skill work in Hamburg (taken as a proxy, since no overall minimum wage exists in Germany). We found that, in the US, around 26 percent of labor is employed at below official French minimum wage costs to the employer (Exhibit 8). This was to a large extent due to the comparatively high social charges to be paid for by the employer. Economy-wide positive spillover effects Output and employment performance of one industry also suffer from barriers to higher productivity or output in other sectors of the economy (spillover effects). The French and German computersojlrmreindustries, for example, are restricted in output and employment by the lack of a vibrant service sector in their local markets. For example, external IT spending per capita in the US financial services sectors -20 percent of total external IT spending in the US - is almost twice as high as in France, and almost three times the German level. Per unit of output the US has almost 40 percent higher IT spending throughout the economy. In total, the US uses almost twice as much computer software per capita as either France or Germany (Exhibit 9). Positive spillover effects from removing barriers in other sectors emerged from our industry case studies as being very important to output and employment growth. These positive spillover effects include the increased income generated by the redeployment of resources from mature to growing sectors. To maximize these effects, flexibility of labor and capital markets have to be ensured.

IMPROVING ECONOMIC AND SOCIAL PERFORMANCE Most of the regulations that stifle output andjob growth have been put in place to meet social objectives, such as preserving income levels (e.g., high minimum wages), providing universal access to key infrastructure(e.g., low telecom subscription fees), and preventing job losses (e.g., trade barriers in automotive). However, in addition to having a negative impact on economic performance, they often lead to secondary effects which actually thwart the social objectives sought in the first place. Rather than guaranteeinga high standard of living, high minimum wages actually keep low-skilled workers out of the workforce. Rather than ensuring the full benefits of a well established telecom infrastructure, low subscription fees combinedwith artificially high call rates have actually constrained usage, especially for the poor. A history of protecting auto markets

5

E54W1BPA.2XWCC5~.BBSID

Exhibit10

)ECOUPLINGECONOMICAND SOCIALPOLICIES Cwr.3ntslt.ati.n PERSONAL INCOME

Deregu!atedmarkots ;SSO;AL

$&al 0/

GmnihcmmlralnwJ Inthename Ofsoclal objectives . Highminim. mw.ge . Highlocal telemmrates .

- SyiMr&r.31e.dsofprsO@imOnw .“rc%:MeW,say

Gsin

lncwasedgmwh, butsocial Problems . Higher empl.ymmt, b.tlmver wages fo,thelc.wskfllml . lncreasedwage dueIOIOWW rates, butm.reexwnslve access Ioteleenn [nfmstruchm .

970221du3m,-262423_O05-F2SW

in Europe will in the long run cost more jobs with the opening of the European markets than it has saved. However, there is the possibility for real, practical reforms which align economic and social objectives. Increased flexibility in the product, capital, and labor markets, aimed at opening up the way to economic growth, can be accompaniedby explicit and targeted need-based social policies like a negative income tax to compensate for lower minimumwages, and telecom subsidies to the needy to make up for higher subscriptionfees. This should allow France and Germany to achieve improved economic performance and the intended social objectives at the same time (Exhibit 10). In each of the industries we stodied, we found many “man-made”barriers to higher growth and employment. This suggests that removing such barriers across the board, or at least revising them with an eye toward their economic implications, will have tremendouspositive impact on the economies of France and Germany.

6 —

970221du3sw_262423-C05-FIOSW

Objectives and Approach Unemployment rates in France and Germany have been rising alarmingly since the early seventies when they were well below the 3 percent mark. The standardized OECD unemploymentrate in France surpassed the 10 percent mark in the mid-1980s and is now at 11.6 percent. In Germany, the share of those workers who are either unemployed or receive active labor market support now exceeds 9 percent of the labor force (Exhibit 1). At the same time, economic growth in France and Germany has been slowing down both relative to the 1970s and 1980s and relative to other industrializedcountries (Exhibit 2). For instance, the gap in per capita income of France and Germany to the per capita income of the United States has increased again since the early 1990s.The fear that the economies of France and Germany have entered an enduring stage of slow and jobless growth has caused a sense of economiccrisis and has precipitated a lively discussion about its causes and implicationsfor policy and management in both countries.

OBJECTIVE OF THIS STUDY Against this backdrop, the purpose of this study is to evaluate France and West Germany in terms of productivity, output, and employment performance at the industry level. In particular, we benchmark French and West German productivity, output and employment levels against selected major economies across the world. We then identify the causes of differences, determine their relative importance, and draw implicationsfor policy and managementin France and Germany. While this report does not address the specific problems of East Germany and only investigatesWest German economic performance, the general insights should be applicable to Germany as a whole. French and German economicperformance and its causes have been the focus of many studies on both the scholarly level and in the popular press. Frequently cited causes for slow growth and high unemployment are fiscal and monetary policies, labor market inflexibility, the effect of the generous social safety net on economic incentives, and a lack of competition from non-EU countries. What seems to be lacking is systematic evidence about the relative importance of these and other factors. McKinsey’sprevious work on productivity and employment has shown that evidence about the importance of these factors can be found at the industry level. The objective of this report is therefore to conduct industry level analyses in France and Germany that complement the existing literature. To accomplish that, we have taken a case study approach to identify barriers to faster growth and higher employment in a set of key industries. We use industry data, knowledge gained from McKinsey’swork, and interviews to determine

OA~I>PA.ZXWW2502BB.XID Exhibil1

STANDARDIZED”UNEMPLOYMENTRATE-1970 -1995 Percentof totalIaborforce

-. WeslGermany . . . France

14-

1995

12 10

●.

6-

●+*

42-

...... ●.

. ●“

8

..=”

.

●.*

““”;\= .“” ,/

.“ .“

..+ .,

11.5 France

.“ “... ”

N+-

9.1 Germany,including activelabormarket support

/-

\ \’

7.0 Germany a

\,/

/1

. . . . . . . $“----’ ---

/’

0 ,0 ,%,Q t“ .~~ ,46 ,4*

( \9%Q\9%%.@k ,9%6\9%%.@” \q~%\9%b.995

- %n&tiizti .nempl.ymentrate., ~le.httibyE.msutfor OEcD,b.sedon mti.nalho.setilds S.wey.(ea.hnetional s.myind.des tisarm W.stm.t.assess unemploymmt lnacomparable manner); thes~ndardized mtev.o%in 1995) dillwsfr0mthe publishti ”al,.”alWest Gemm

rat.3baWd o.!he G.mmnIAmrOflIcatig”res because Hdm$”ot,n.lude anaddtiioml 1.3V.rq,.tered..employedwbwillIlotacceptajcbwithi. Mweeks.sslatwJinmeiw.seiwldsuw.,andb~u$e meotid.l Germnmterelate..nempbydtotomlIaborforce minwsev-empb ed.na oficialW.stGennan.rmmp!ee“tr?,teis.3h,,f EastGermany islncluded, 10.4%.TheOECDstandardized .n.mployment mtef.rthedSk5.6%. {. b“rc%:OECDEmPbyirent O”U@ok 1r 96,McKiIsey

Exhibit2

CHANGE IN GROSS DOMESTIC PRODUCT- 1970-1995

France

Germany

3.2

mm 1970s

80s 1992-95

United States

1970s

80s 1992-95

United Kingdom 3.6

mm 1970s 2ou,ce:McK(mey

80s 1992-95

1970s

80s 1992-95

OA57812-+PA-7-W+M5.2W2.B.XID

..,,,.,, . GDP” PER CAPITA AT GDP PPPH - 1970-1995

— -. --GDP percapita, converted at 1993 GDP PPP ?5,000-

us We,,Germa”y France

Indexedto US = 100 120110 -

20,000100 !5,000 -

90 -

10,000..”

_#-e*-~ 80 - -@#-# -..=.+ ........ ........ 70 .==. *

O+\~, +””*+..

60 5,000 -

0 1970

,,, 75

80

85

90

o’~ 1970

1995

75

80

85

90

1995

Excludin rmtsand indirect laxes ... DM2.1~S$and FF6.wJS $ SWme:OECDNatimalA ccn.nts,INSEEmmpte., Statislisches Bundesam, BEASCB, E.rostat PPP,OECDPPP, McKinsey

ExhlbN4 TOTAL FACTOR PRODUCTIVITYIN MARKSTSECTOR’ -1970-1995 Indexedto US = 100 — us -. WeSGerrr@nY . . . F,?.-

11o100 4?.%

90 ,5+

80 .. .*-P.-* ,.. ...+,70 --.

“%wdu+p

“*

60 -

,,, :970

,,, 1975

,!

,,, 1980

,,, 1985

,,,

,,, 1990

J 1995

- Tomlfatiorprtitiwi. deti&WWW% .C&&cougbs procltw!ion tundiontimalatc+shareofw,, Sourca:O,Maheny.lNSEE comPles, SWislisclwsB” &samt,8EAWeaHh, BEASCB,OECDN.tiMAOWU”tS, OECD-Force Slatis!ks. OECDEmpby,Tmnt Otilc.akEurostat PPP,OECDPPP,OECDS?,DB, McKinsay

0A970129.PA.2xw05-250.BB..xID =“.,.:,. ~..,,l.,,

.

EMPLOYMENTPER WORKING AGE POPULATION*-1970-1995 Percent — us -m westGermany . . . France 75-

70 65 ~

55 50-

- F.ll.timeequivalenm (ad]..ttifor diHerenws Inho.rsworked) perworkirq agepopulatio. (~le 15t064years.w) ICJJC3:OECDNabatiAcm.nts,OEcDEmployment 0u800k,0EcDLaterForceStatistics, nati.mal s.tisticsMcKinsey

Exhibh6 LABOR INPU7 COMPARISON-1970-1995

— us -. w.3st G.mav . . . Fra”m Annualhourslemployed 2,000. 1,900 ?;”;...+ \ 1,800

●=..* ~\/\

“...

.

\\\”’*, -e. 1,700

-15Y0 . . . ..

+.< .---

1990

1994

14 YSARS-1990

VS. 19S4

cAGR (percent)

‘ranchesFys82=n-

““

:YE41

SC+IIC%: BIS,FlGFadd9ti,

E.

MeKmsey

‘:

970225DU$SW-262423-CfJ3-F14SW

to offset the overall loss. The question,however, remains why the specific situation in France with high government ownership and strong union infhrencehas not made it impossible to have such a lean employment structure. On the one hand, there appears to be an implicit agreement for all banks to avoid mass layoffs, while, on the other hand, French banks explicitly focused on cost-cuttingto escape the profit squeeze in the retail market since the mid-1980s. French banks thus seem to have mainly relied on natural attrition coupled with a slowdownon new hires to reduce labor, as reflected in the age structure. Looking at the employment performanceby product groups, it appears that the US has already started with rationalizationin traditional product areas, while there is strong growth coming from new products such as securities and mortgages. Mortgage employment is, however, strongly infhrencedby the interest rate cycle and thus very volatile. In West Germany, the main growth areas are also loans and securities (but to a lesser degree than for the US). However, we also still see increasing employment in traditionalproducts (Exhibit 21). The employment increase in Germany does not appear to be sustainable. It is mainlv driven bv the high density of the branch network (80 percent more br’anchespe~inhabi~antthan-inthe US and still 40 percent more than in France). However, with automationin banking increasing rapidly (number of ATMs per inhabitanthas more than doubled between 1990 and 1994) and consumersincreasinglyusing electronic banking via phone and PC, the branch network is likely to decline as has already happened in the US (Exhibit 22). Moreover, the performance orientation of the German consumers also appears to increase. Over time, the main rationale to establish the dense branch network, i.e., the collection of cheap deposits, will thus also decrease. The level of employment as measured in hours worked in retail banking per inhabitant of 14 years of age or older is 15 percent higher in the US than in West Germany and almost 40 percent higher than in France. This gap in employment can be explained mainly by differences in output. Taking the differences in labor productivity into account, the gap for West Germany widens to approximately 30 percent.

SUMMARY AND IMPLICATIONS Given the significantproductivity differences on product category levels, there is major productivity improvementpotential for both France and West Germany in comparison with the US. Although some of the potential might not be easily achievable due to legislative constraintsor the need for thorough reorganization,

15

F.B3701BPA.ZXWC05.WR.BLX

Exhibi123

IN FRANCEAND GERMANY FTE ’000 Germany CurrentflE’

494

Productivity increases in all productcategoriesto US level

202

EfficientHE withincurrent paymentsystem Transitionto advanced paymentsystem” EfficientFTE withadvanced paymentsystem Employmentgrowthby reaching US penetrationinall productcategories’”’ EfficientHE withadvanced paymentsystemand US productpenetration

I 292

10 0’0

- Flgureincl.des wtilew!eS!=atfin PaYmenLs ‘- &.mp!rnn:50%ofm.enttiecb tod,rtidebit.nd25”htopaperless cmdittrarsfer ‘.. Take91nm a-u”tt%hnologi=l imPro.emenS i”Pape.t Syslemandin terdeperdemies kw-nmovet. fu~edvnsbnsptem atihigherwnetrabon inbam Zo”rce: McKimeY

970225DU&W_262423_O05-F14SW

the maximurnlevel of productivity improvements,including the shift to a fully electronic payment system in France, could reduce employment in the retail banking sector by 40 percent in West Germany and 33 percent in France (a reduction of 206,000 FTEs in West Germany and 98,000 FTEs in France) (Exhibit 23). In West Germany, major restructuringneeds to be done in payments and also in loans, whereas, in France, rationalizationis needed almost exclusively in payments. Simply closing the productivity gap to the US in payments would represent an employment reduction by 48,000 ITEs in West Germany and 29,000 FTEs in France. However, fully leveraging the electronic payment systems advantage and thus surpassingUS productivity would require an additional labor reduction of 94,000 FTEs in West Germany and 35,000 FTEs in France. There is also potential in retail banking to partially offset the decline in employment. It could come from continuedsubstitutionof cash payments, but particularly from higher penetration of loans and increased sales of managed assets and securities. The number of jobs created in the latter area ultimately depends on how the focus on funded retirement provisions in France and West Germany develops. To estimate the potential for job creation in non-cashpayments, loans, and securities, the respective US penetration per US $ invested has been used as a benchmark, with the US being the most advancedcountry in these areas. However, to achieve a realistic estimate, it is necessary to incorporate the specific starting position for both France and West Germany. ~ Taking technologicalprogress into account, there will be relatively little employment created through an increase in non-cash payments. y Increasing penetration in securities will probably go along with job losses in deposits, since funds are partially just being shifted between asset classes. As a consequenceof this tradeoff, the net effect on new employment will also be limited. To estimate the tradeoff, the current US penetration for deposits and securities per inhabitant is applied to Germany and France. y In loans, the potential appears to be highest in France. The already relatively high degree of indebtednessof German consumers implies relatively lower job creation when compared to France. In the following, we highlight what in our view are the most important issues for the agenda of the policymakers in France and West Germany. On the whole we believe that the main task for public policy is to focus on an open and competitive retail banking industry. To achieve this goal, it is necessary to provide for a level playing field for all competitors and reconsider the tradeoffs between societal objectives and the costs that result from a more rigid regulatory framework.

16

970225DU&W-262423-LM5-F14SW

On a public policy level, several change drivers can be identified for France and West Germany that could help increaseproductivity and employment. ~ France: Increasing pressure on corporate governance structures and reducing government interventionin the banking sector in order not to distort the results of a free competitionwould allow French banks to stay on the track of world-classproductivitywithout suffering from distorted competition. Reducing govermnent intervention in France has three facets. .

Direct government interventionby government ownership or by ‘%ailingout” failing banks preserves overcapacity in the market and distorts incentivesfor thrifty management.

. Removing product privileges for certain banks would probably not decrease overall competitive intensity. However, it would be a signal that the government is willing to support free and fair competition. It would allow publicly quoted banks to establish a sound basis in the retail market sector and face internationalcompetition in the wholesale market more easily. .

Removing product regulation such as the legal requirement that checks and checking accountsbe free of charge will allow French banks to decrease cross-subsidiesin payments and consumers in France to reveal their true preferences. The underlying social objective of free access to the payment system could be achieved by targeted support for the needy.

~ West Germany and France: For both countries,increasing consumers’ performance orientationand increasingpressure from competition and capital markets represent major challenges. Productivity in the retail banking industry would thus clearly benefit from a stronger focus on funded retirement provisions from both individualsand companies. .

.

.

The need to provide individuallyfor retirement and the higher volume of personal financial assets per capita are likely to increase performance orientation of the consumer and consequently the share of security investments. The need to manage the increasingvolume of retirement funds will probably also give rise to independentpension fund companies. The US experience suggests that investor activismwill increase the shareholder value orientation and thus the pressure for productivity improvements. Fostering the broad use of new distributionchannelsfor financial products, such as phone or PC, would lower the barriers of entry for specialized players and thus increase competitive pressure.

17

B3+701BPA.ZWCC52WMBX,D

SUMMARY- RE7AIL CASE

‘

/“1IGermany ~~J‡ 70 Indexed

to

us. 100

(1994)

Q\

France

-y

@

i%%y

65

Q

,mp,oymen,

100

70

100

65

I Recommendations ● Reducethe costof low-skilledIaborto enablethe delivery

of additionalsewices . RelaxzoningIawstofosterthe developmentof modsm, morelabor-intensive formats(e.g., s ecialtychains) ● Rem nize retailas a keysecforfor!utureemployment growlf , as consumption of non-basic,service-intensive productsis ve!ysensitiveto GDP growth

\:’”””l

-:

.“,,”,

970221du3stt-262423-005-F15SW

Retail Case EXECUTIVE SUMMARY Retail is a fundamentalpart of any economyboth in terms of share of GDP (5 to 6 percent) and share of employment (4 to 7 percent of working age population, 7 to 11 percent of total employment). Large cross-countrydifferences in terms of output and employment levels make this industry essential to our understanding of the barriers to growth and especially employment. Among the sectors studied, retail exemplifies the impact of minimum wage on low-skilled employment. Despite a constrainingregulatoq environment aimed at protecting employment and urbanism, retail sectors in France and West Germany managed to rapidly develop modem formats. As a result, productivity as estimated in both countries is nearly at par with the US. The high share of “productive”large-scale formats offsets the relatively high-but-declining-shareof protected traditional stores. Since 1973, the US retail trade industryhas created eight jobs per thousand WAP whereas the French and West German retail industries have destroyed 4 and 1 respectively. As a result, the retail trade employment level is currently 50 percent higher in the US than in France and West Germany. Notwithstanding lower income level translating into lower consumptionof non-basicproducts and related services, regulationssignificantlyimpacted employment: T France and West Germany work fewer hours within comparable formats due to much higher labor costs, forcing employers to provide less service and therefore less hours of work. ~ The modern format mix in France and West Germany has more highly efficient and high-service formats. .

Zoning laws and stringent opening hours constrain the development of modern high-service formats in suburbancommercial centers.

. Development of high-service formats is also constrainedby a much higher cost of differentiation(especially given lower income levels) resulting from much higher labor costs (due to high minimum wages) and land costs (due to zoning laws). ‘II Consumption ofnon-basic products, typically requiring more service, is also affected by higher value-added tax (VAT) rates on these products. Reducing the cost of low-skilled labor while removing constrainingproduct market regulations (zoning laws and opening hours) could allow employment

RE970119PA-mc0$2m2.Lmx,D

~...,, ”,,

,

SUBSECTORSINCLUDEDIN THE RHAIL SECTORAS DEFINEDIN uS, FRANCE, AND WEST GERMANY Percentand US $ in 1993,convertedat GDP PPP ~

us 1995

France1994

Eating~;~e;nnking

~adim=mim

West Germany 1992 Drugstores

Drugstores

A

Ga

acopa.fmesmdy

od

Au d F.xd

-focff Non-food 100% =

30-:

2,150 billionUS $

274 billionUS $

327 billionUS $

- ForFmnw, Sbsofgamllne ati~, awssriesmdebys.wmake6atihWmake& LE~pattmmt oIconmer~, INSEE, ~mpmsd.mmmer~, Sa!htic~sBunde-t,McKinsey

Etiibi12 DEFINITIONS AND EXAMPLESFOR THE VARIOUS FORMATCATEGORIES- RETAIL

Fommttype DO finiti.nfcriteria uanxamph. Frenchexamples Multi-category farge-sc%retailers selli”g primarilyKrcger, Safeway, Arneriea”Carrefou,.Lederc,

maea rnerchan. focalatlowprices;grmssmmgins Stores,Alfx?rtsonms, Pmmode3,Aucha”, dizers ~@#~~~::f;afeS; id. discount Wi..-Dixio, GreatAtlantic&Casino Pacific,Wal-Mewt, KMat, Tarpet Larga-sc91e Large-scaleretaile~sellingprimarilyli;;\;~@,Toys,R Us, Darly,FNAC.DeathIon, .Wiali.ts non-fccdpmductsin aspecific Castorama,Conforama, range,operatingstoresover1,5D0 TOYS,Rus, CaA, Ikea sqrn;grossmarginslypicallyaro.”d 30% The Gap,The DisneyStore,GroupeAndc+,Emm, Sp=ciakv.h.ins Reta~ler.s sellingprti.ctsina spec,ficrange. operatingstems.[ess The Lirnitet Zara,TheGap,The than1,5Wsqmata~m!gross DisneyStore margmof40%, i“cl. esfm”chise Large-scaleretailerssellin abrcad May,Federated,Sews, Printemps,Gaieties ~wfi~.t Storas mngeofprimadlynonf~pti.cts, .LC.F’ennoy Lafayette.BHV,Le Bon Owmtingstoreswfih%lling,spam Marche,la Sewnwilal”e 0v:3v~~~~m~gr0s5 nmrgms Wii:onal

Mail otir houaea

3muce: McK2msay

Independent indirid.alretailers Grocer3,bakeries,snmll W.w3tinga singleestablishment with specfallyboutiques fessf@7 1OemplOyees (w3.55 maQtnsfyplc.aJfy 45%, exceptin Germany) LLaean, Lalm-sEnd. [email protected] Rghl Slafi

WestGerman examples Edeka,Rewe, Tengelmann, Aldi,Spar, Lidl&Schwarz,AJlkauf, MassaandReal(Metro) C2.A,Ikea,M6bslFranz. S!.., Hen... & Ma.riQ, MediaM.rkl, Obi, Prakiiker(AskaMetro) ;{’~B:&2::P#i!s? Karstadt&Heflie (Karstadt),Kaufhof, Hotien& Ka.fhalle (Mekogm.p)

Grcm8rs, bakeries,small Grocers,Bakeries.small specialtyboutiques speeiailyk.wliques

La RedmI@ Les3SLissas

Gno.Owb. Neckerrmann

970221du3suz_262423-005.F15SW

creation in line with GDP growth in the French and West German retail industries.

INDUSTRY STRUCTURE

Scope of the study The sectors that form retailing are many and diverse, with significant differences between countries. The following analysisincludes both food and non-food retail (it excludes wholesale trade). Definitions of retail trade differ across countries. US statistics include some subsectors not included in European statistics. Consequently,for data consistency purposes, the following sub-sectorswere excluded: automotivedealers and gasoline service stations (consideredboth in the US and in West Germany as part of the retail sector), eating and drinking places (consideredor-dyin the US as part of the retail sector) and drugstores. For France, we excluded sales of gasoline and car accessories made by food retailers (Exhibit 1). Format mix Retailers tend to think of retail along food and non-food charnels. However, many large retailers, especially large European food retailers, carry both types of products. Also, the retailing industry is actually a continuumof value propositions ranging from hard discountwith no service to very high price with outstanding service. For the purpose of this analysis,the industry was segmented along six aggregates: traditional stores, department stores, specialty chains, large-scale specialists, multi-categorymass merchandisers,and mail order houses (Exhibit 2). Although such a segmentationdoes not fully encompass the variety of value propositions made by the different retailers, it is sufficient for the purpose of our analysis. When comparing sales format mix across countries (Exhibit 3), the following key differences are observed in France and Germany relative to the US. Y Large efficient formats (multi category mass merchandisers and largescale specialized chains), in France known as “hypermarkets”,are more developed in France than in the US. ~ Modem high-service formats (speciaky chains and, potentially, department stores) are less developed than in the US. ~ Traditional stores stilIhave a large market share.

2

RE9?JIz?.PA.ZWJWM5U2.BB.XID

....:. >” Cxr!l.iio RELATIVEWEIGHTS OF RHAIL FORMATSANALVZED-TOTAL RETAILTRADE Percentof totalsales

us 1995

France 1994

ESJIMATESFOR GERMANY

Germany 1995

:~4~40~35

scurm:INsEE, statisisches Bwdesamt, USBureau ofCOmmerw. RemilerS~~:at~n,. IFO1.stiWMcKi~eY

Exhibit4 ESTIMATES

EVOLUTION OF RETAIL FORMATMIX -1980-1994 Percentmarketsharesgainedilost

US 1995/1980 Multicatego~ massmerchandisers

Mailorder

3

-2

-3

-2

-17

-23

-9

4JJ

7

4

5

Departmentstores

9

6

4

Specialtychains

Traditionalstores

16

2

Large-scale specializedchains

Germany 1995/1980

France 1994/1980

o

0

Sourc%: INSEE. StaMschesB.rdO saInL IFOlmme,USB.r-uof~mer=. Retalem. kasc6atms,E.mSi?tMcKns%y

0

R&970,2+PA.2XWCW-2Wl.BB. XID ..,4,.. ..!,,.,, ..

KEY REGULATIONSAND BUSINESS PRACTICESIN RETAlL

O Nore@alb” @ R@al!e+l

●Vewswictregulatton

Type of regulatioti practice

us

Labor market

. Verylow

o .

. None

● Q +0 “::::$y;;;::arge o “y&Y&:~:;

Zoning laws

●

Highminimumwage

mimmum wage

regulations

West Germany

Fmnce

. Veryhighminimum wags

retailspaceo.tside cities . Notenanttakeoverfee . Lwglease duraUons (10 years)wilhusualtightof tenanttorenewand limRso”rentalprice increases

Raffarin) . Tenanttakeoverfee . Longleasedurations (12years)and auro+natic rightof tenantto renewlease whhlimitedrental primincreases

. ii~u~mning

Opening houm

. Usuaffynoopeningon Sundayafiemcans

O

●

Q

8+Q

“ ::tYz:i’;z::#z::

regulations

2ource:McKiNy

Exhibi16 APPROACH USED TO ASSESS PRODUCTIVITY- RETAlL

us

Germany

France

FO=ml#

Format Format Inn:m: Pm:i;.

Format Format nmrket pmjificshare. (%)

Format prd@-

s;y:~.

(%)

Massmerchand. i.a~scale speualists

‘:: 80 ~.

:8 @?}:;,;25:::~ ~~;;~l;:jji;i -::,,,,2,,,2

‘:::@ 80

Trad.SOP3S

50

@//~~

50

MailOrder

80

@)

Overallcountry prod.ctivily

@

80.6

Speciallychains Dept.stores

. mtittis E’0.cs:mffiwy

ahlattis

5

80

‘:: 80 s. ;~~~., :4:,:~::.:: ;;

@:-2fi;j

‘:uctivity;:es

@

3

@

77.2 :

@

78.8 I

‘6

., null

80

smeoftowgrs$wh

:%’. ~~;:.:l~ .;; , ~;;:;;f:::; ?:’ ;~~~~ ,

Germany France

970221du3sc.,-262423-005-F17SW

Box: Methodology for measuring productivity in retail trade Economists and retail expertshave always failed in measuringand comparing productivitiesin the retail sector. The problem lies in the fact that there is no direct way to measure o“tp”t, i.e., volume of services sold, in that sector. Productivity(labor and capital) asdefinedby value added permit of input factor is difficult (1) to calculate and (2) to compare across countriesin the retaif sector. (1) Value added by a retailer is the output generatedby the company using internalresources, Gross margin, from which value added could be derived,is the differencebetweennet sales and cost of goods sold. It is the amountof money that enables a retaiferto pay for the use of internal and external resources. Gross margin can be broken down into several components:labor costs, rental costs, utilities, transportation,advertising,financialproducts/charges,taxes, and net margin. It is difficult to decide on which of these elementsshouldbe part of the value added by a retailer. As a matter of fact, subcontractedservices or rental paymentsare not an input from retailers, but both are part of their value propositionand retailers can afford them onlybecause of the quality of their value propositionand the way they manage internalresources. (2) PPPs precalculated by OECDfor tfrefinai averageprice of products. These final prices im elude goods and services, but there is no separate PPP for each of those two componentsof final price. Therefore, there is no exact way of comparingthe value added componentsacross coum tries. Measuring labor productivityusing labor costs is also unsatisfactory. In an efficient deregulated labor market, we could expect labor productivityto equal hourly labor cost. However, this is clearly not the case given national labor market regulationsthat distort labor costs across formats (highesthourly labor costs in France are observed in departmentstores because of strong collective agreementsand kmgerjob tenure of employees). %nifarly, it is not possible to measure capital productivityby using rental costs per square meter because of product market regulationsthat distort rental costs across formats (within the same location, a specialty store may pay ten times the rent per sqm ofa hypermarket). After thorough analysis of the above methods,we decidedto calculate relative format productivities in the US, the least regulatedcountry, and to apply those relative productivities to France and West Germany. T

Using gross margin per hour worked as a proxy for labor productivityand gross margin per square meter of selling space as a proxy for capital productivity,we calculated total productivities for each of the six US formatsby weightinglabor and capital productivitiesby their respective shares in gross margin.

I

To calculate the overall productivityof theretailsectorbra given country, we calculated the weighted average productivityof all the formats in this country, using the format shares in total retail gross margin as the format weights.

970221dv3sca_262.223-C05-F15SW

These key differences are even more apparent when looking at market shares in volume of goods, upon conversionwith calculatedformat PPPs. The evolution of sales market shares (Exhibit 4) shows that the strong decline of traditional stores in France and Germany benefited large efficient formats more than modern high-service formats. Key national regulations in retail trade Virtually non-existent in the US, regulations affecting the retail industry are very strict in France and West Germany (Exhibit 5).

PRODUCTIVITY PERFORMANCE Comparison of productivity performance The results show that France and West Germany stand at around 96 indexed to US 100. However, this calculationprovides more of an index of modernity than a pure productivity measure (Exhibit 6). Adjustments for less value-addedservices in France and Germany can be made on the basis that the US has more low-valuejobs (e.g., packing assistants,door keepers). With this adjustment,aggregate retail productivities have been estimated to be roughly at par (see Box: Methodcdogyformeasuring productivity in retail trade). Causes of differences in modernity and productivity Because productivities as estimated across countries are almost at par, causality factors will be discussedin more detail in terms of employment, where a large gap is observable between the US versus France and West Germany (Exhibits 7 and 8). ~ Indusfy dynamics andcompefifive intensify. High competitive intensity has prevailed both in France and West Germany among industry players despite strict zoning laws in both countries and restricted opening hours in West Germany. At the aggregate sector level, price competition (reflected in shrinking margins) and rapid movements in market shares testify to the high level of competitive intensity. Behaviors of industry players are also quite illustrative of competitive intensity: .

Ability of French hypennarket chains to successfullydevelop their concept in Europe, Asia, and South America, and to take retail lead-

3

P.E~129.PA.ZWLX52XlXBB,X,D

Exhibil7

PRODUCTIVITY”CAUSALfTV- RETAIL

Causes

Regulation

Ftzmceva. US

Germanyvs. US

Labor market factora

. Labor costs

. CuttingoffIow-valuejobsledto higher throughputbutIowersewicecontent . No majorbanfersfortraditionalsas self-employd

. Cuffingoff Iow-valuejobsledto higherthroughputbutlowersewice content . No majorbarriersfortraditionalsas self-employed

. Labor rulesl unionism

. RigidIaboragreementscauseddeclineof departmentstores(higherIaborcostsand lessflexibilityof workorganization)

. Rigidlaboragreementscaused deslineof depatimentstores (higherIaborcostsandless flexibilityof workorganization)

. .ZZnJng

. Did notpreventfooddiscounters from rowingand competingwitheachother .~lightlym”strai”edspwial~chains ● Slightlyprotestedtraditionalstores . Wouldnothavepreventeddevelopmentof departmentstores

. Proac!”we developmentof innercity shoppinggalleriesand pedestria” areaaincreasedconvenienceof traditionalstores

Product market factors

. Opening hours

o Protectedtraditionalstores

Heavy regulations onlyalightlyaffected competitive intensify but favored Iage-scaie efficient formats at the expense of modem labor-intensive ones . Basedontorrnatmixana~is SnUrm:McKhs%y

Etiibiia .

●Imp.aliant,

CAUSALIN FOR PRODUCTIVITY”DIFFERENCES- RETAlL

Extemalfactors

n

m Production prmess

D

. i 2 3

Country comparison GFG vs. vs. vs. US US F XX* .——————

O%ml?da,-f X Undtier@atiW

. Fsca!and macroemnomc envronment :Tra”d—nlar— ———————— *XX - CompetitiOnJwncenbatiOn rules -TradeFD1basis xxx – Product regulations 000 xxx - Otherindustnes/up. anddwmstremm .—————————————— .—————— . Labor market x - Labor rulesJunionism - Relative Iaborcost :4 : 4 x ~7%FiafiaToT ————————— - Corporate govemanmlgovemmento wnership n t! x xxx - Relative mstofcapit?.tintermediation . @repetition witibestpmdim

xxx

. Domesdccnmpetitive intensify

00=

yflix10 permntigeWin&ofm-rdlprtitiy dmerencas Expbinirg3.IO@rmnWge WinSof~o.etil vtic@@f$lferercM EVkinirqO. 3p3rcen@ep o.k. fmeoWraJ1Pfcdmtyd?flemrcas S.urea:McKimay

04 04 * .—————— 05 05 x Xxo xxx .—————— xxx n.a. n.a. Xxo IDD IDO

n.% 100

4 cmngorfkswval uejcbsms.ns ininmeasi~,aggrqate prtititiy 5 Lower”-o flTetdewnmn!sto’esWd”ad,lbndstores 6 TraditbWlstores purti.%fmm bWnggrovs )

970221d&z-262423-005-F15SW

ership, sometimes at the expense of US players (Carrefour against Wal-Mart in Brazil) ●

Successesof Aldiand Tengelmannoutside Germany withrespectively 30 percent and 50 percent of their revenues abroad

●

Fast growth in the US of supercenters,a new format close to the French hypermarket, launchedby US discountstores

●

Decline of French department stores, rapidly penalized by the market for not having modernized their value proposition

~ Impact ofregulafions onformat mix in France and West Germany relative to the US. Although they did not prevent high competitive intensity, regulations in place had some impacts on the format mix. The difference observed in format mix comes mostly from the higher market shares held by traditional stores in France and West Germany than in the US, compensatedfor by higher shares of large-scale formats. The US have more specialty chains and department stores. .

In France, zoning laws did not prevent the fast growth of food discounters and large-scale specialists. They protected traditional stores to a limited extent. – Zoning laws protected already established traditional stores, which are the least productive format, and did not encourage them to modernize their value proposition, except for franchises (6 percent of retail trade in France). They did notpreventmodem food discounters (hypermarketsand supermarkets) from growing. They only slightly constrainedthe development of modern specialty chainswithin suburbanmalls and would not have constrained the development of department stores, which were primarily affected by poor corporate governance and labor market regulation. – Fairly flexible opening hours regulationshad a relatively low impact on the development of new formats since they did not protect traditional stores.

.

In West Germany, althoughvery strict zoning laws and opening hours regulations constrainedthe development of trade outside the cities, proactive developmentof city centers has preserved a wealth of space, fostering competitionwithin city centers. – Proactive developmentof inner city shopping galleries and pedestrian areas increased relative convenienceof traditional stores by rendering suburbanshopping more difficult, but which remained competitive thanks to purchasing from buying groups.

4 —

—

RE9m,z-PA-mm$2m2.BB. xlD

Exhibit9 RETAIL EMPLOYMENT LEVEL AND GROWTH -1993 VS. 19i7’

Houraworkedper workingage population”

1993

7977 120

+50% 82

79

Mll us

France Germany

. Pe@e15t064ye.=o!d S+wce: INSEE,USB.rea.olLaLnrStatistics, SlalislistiesButi-mt, McKinSeY

ExhibS10

HOURSWORKED IN RETAILTRADE- FRANCEVS. US -1994 30WSworkadin nationalretailtrade perworkingage population

120

F ir tl

rswork, S retail ?

24

n

12’ ““””””””n

Less goods

purchased

.—

5

79

Less hours Lesshours Hourswork, workedin workeddue in French comparableto lesslabor- retailtrade intensive formats formats

9702 Hd.3s.,-262423-005-F15SW

- Very strict opening hours regulationshave protected proximity business (traditionalstores), but they also increased throughput per hour worked of all formats by confining shopping to limited hours. . In both countries,higher labor costs and relatively higher VAT levels also constrainedthe development of specialty chains and department stores and favored the developmentof large-scale formats.

OUTPUT AND EMPLOYMENT PERFORMANCE Since productivities across the three countries are almost at par and given the difficulty of measuring output (service) in this sector, we have analyzed the differences in employment levels. Comparison of employment level and performance Employment levels in France and West Germany are much lower than in the US. The US retail trade employs 7.4 percent of the WAP, versus 4.3 percent for France and 5 percent for West Germany. After adjustmentfor hours worked, the US retail sector has 52 percent and 46 percent more input than France and West Germany respectively (Exhibit9). Net job creation by the retail sector has been much better over the last twenty years in the US than in France and West Germany. Since 1973, the US retail sector created eight jobs per thousandworking age population whereas West Germany destroyed one and France destroyed four. Causes of differences in employment level and performance The employment gaps between the US on the one hand and France and West Germany on the other hand can be disaggregatedinto three major blocks (Exhibits 10 and 11). q Fewer goods purchased in France and West Germany than in the US ~ Fewer hours worked in comparable format in France and West Germany than in the US ‘j Fewer hours worked due to less labor-intensiveformats in France and West Germany than in the US The impact of causal factors on each of these three blocks is discussedbelow (Exhibits 12 and 13).

5

RE~1Z9.PA.ZXWWW.W2.BB.X,D

.. . HOURS WORKED IN REfAILTRADE - GERMANYVS. US -1994 Hoursworkedin nationalretailtrade perwoddngsge pepula!ion

.

120

21

❑ –-”-””n.............-,-1

82

v 17

Hoursworked Fewergocds Fewerhours workedin in US retail purchased comparable trade formats”

I

Fewerhours Hoursworked workeddue in German to lesslabor- retailtrade intensive formats

- Restivelyhighstireollr.ditionalstores .HsetingbwersMreolmtiernh@hseMwformats lnGerm.ny b“’cn: MCKi!lS%y

Exhibil12

SUMMARYOF EMPLOYMENTCAUSALITY- RETAIL

Lower GDP per capita Higher relative VAT cm non-basicproducts

Labor market regulations

Zoning laws

Opaning houns

~

Keyimpactm

emp!o~ent level

Fewer hours worked in Fewer goods purchased comparableformats

Fewer hours worked due to less Iabor-intensiveformats

~;~~~OWe’r>~riSUrn”’tlO~ ~f~< . Lowerconsumption of :,,~U~ wvices ‘:non-basic:p

. Lowerconsumption in high serviceformats

;;ocowe,~con